A step back

11Jul07

We came across a handful of research-related items of an academic bent that did not seem to fit in the today’s daily linkfest.  Investors can get too wrapped up in the day to day happenings of the capital markets. A step back can help provide some needed perspective.

One of the main arguments for the existence (and flourishing) of hedge funds is their ability to conduct arbitrage. However profitable an arbitrage situation might be it is not without risk. A position can move against the arbitrageur. A paper, “Slow Moving Capital” by Mitchell, Pedersen and Pulvino at SSRN.com addresses this very issue. They use three case studies to show how mark-to-market losses can impede a firm’s ability to fully profit from their implementation of “arbitrage capital.”

Mutual fund investors fare no better. In a paper entitled, “Mutual Fund Flows and Investor Returns: An Empirical Examination of Fund Investor Timing Ability” by Friesen and Sapp at SSRN.com calculate the actual return shortfall to mutual fund investors by market timing. That is, the headline returns on mutual funds overstate the actual returns of investors due to their propensity to buy high and sell low.

Eddy Elfenbein at Crossing Wall Street takes to task an article that extols the virtues of dollar cost averaging. Eddy notes how DCA does have its place, but it has been shown to be inferior to a lump sum investment strategy. The logic is simple, but it boils down to: “Don’t diversify by time, diversify by assets.”

Helen Thomas at FT Alphaville highlights some research by Dresdner Kleinwort showing the inability of analysts to forecast corporate earnings. Rather than wasting time forecasting the future there may be more value in analyzing the past. A relatively simple financial model based on accounting data has shown the ability to discriminate amongst companies with improving and deteriorating fundamentals.

This is by no means an exhaustive review of interesting academic literature, merely a sampling of items we have come across. If you know of an interesting paper that deserves a wider readership please feel free to pass it along.

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